How to Give Your Grandkids a Head Start

Consider these savvy strategies to help fund your grandchildren’s college education.

• FIDELITY VIEWPOINTS
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• As a grandparent, you may feel that one of the most helpful things you can do to contribute to your grandchildren's future success is to contribute to their college education. In fact, according to Fidelity’s 2014 Grandparents and College Savings Study, 72% of grandparents think it’s important to help pay for their grandchildren’s college education, and more than half (53%) are currently contributing, or planning to help them save.1
  But how and where should you begin saving? Also, what factors should you consider?

  Consider your account options

  When evaluating the best college savings option for you, it's important to consider your financial situation, your grandchildren's circumstances, and the financial situation of your grandchildren's parents. Also, consider the tax advantages of each type of account, both on the federal and the state.
  There are three main tax-advantaged college savings vehicles to consider:
  1. The 529 college savings plan is by far the most popular of the three. It offers favorable financial aid treatment, tax advantages, and a great degree of flexibility and control for account holders. These savings plans are particularly attractive to grandparents who want to lower the value of their taxable estate.
  2. Custodial accounts, either Uniform Gifts to Minors Act (UGMA) accounts or Uniform Transfers to Minors Acts (UTMA) accounts, offer more investment choices, but may weigh more heavily on financial aid. They offer limited tax benefits in that a portion of earnings may be taxed at the child’s tax rate, and the money saved becomes the child’s at a certain age, regardless of whether he or she goes on to college.
  3. The Coverdell education savings account (ESA) offers tax advantages similar those of the 529 plan, but has a $2,000 annual cap on contributions. Still, if you're contributing only $2,000 or less per year, these savings vehicles can be attractive, particularly because they offer a broad range of investment options. (Note: Fidelity does not offer Coverdell ESAs.)
  We describe all three types of accounts below in detail, from the perspective of a grandparent. Before you choose one, consider the questions in the boxes to the right in the sections below.

  529 plans offer many benefits.

  The 529 college savings plan offers several features, which can vary from state to state, but in general most 529 plans offer:
  • Tax advantages. Withdrawals from 529 college savings plans are federal income tax free when you use them for qualified higher education expenses. This includes tuition, books, fees, supplies, and other approved expenses at eligible institutions.
  • Control. When you open a 529 account with a grandchild as beneficiary, you maintain control of the account, which lets you decide when to disburse the proceeds; you can even decide to change the beneficiary, if desired.2 Or, if the parent opens the 529 account, you can simply gift to that account and the parent maintains control.
  • Front-loading of college savings. Grandparents can front-load a 529 plan (giving five years' worth of annual gifts of up to $14,000 at once, for a total of up to $70,000 per grandparent, per beneficiary) without having to pay a gift tax or chip away at the lifetime gift tax exclusion.3 This would allow more time for these savings to potentially grow tax deferred (see discussion below on gifting). It could also potentially lower the value of your taxable estate.
  • Minimal impact on financial aid. Because 529 college savings plans are considered parental assets, they are included in the Expected Family Contribution (EFC) calculation for federal financial aid, and count for up to 5.6% of assets (versus 20% for a student asset such as a UGMA/UTMA account).
  • One catch to consider for a grandparent’s 529 account. A 529 account held by a grandparent is treated differently for the purposes of student aid. The account balance isn’t included as an asset in the EFC calculation. However, once the money is distributed, it is considered student income. Student income can have a significant impact on financial aid. (See further discussion below.) "A gift from a grandparent is seen as an indication that there’s more income that the student could be using," says Keith Bernhardt, vice president of college planning at Fidelity Investments.
  • Investment options. A 529 plan offers a selection of investment options, often including age-based investment options that automatically become more conservative as the beneficiary approaches college age. However, the range of options is not as broad as those available in Coverdell ESAs or UTMA/UGMA brokerage accounts. For example, you cannot invest in individual stocks through a 529 plan.
  • Withdrawing money. You could withdraw the money yourself at any point. However, be prepared to pay income taxes on any earnings, plus a 10% penalty on those earnings if the money is not used for qualified higher education expenses.

  UGMAs/UTMAs belong to the beneficiary.

  A parent or grandparent can use a custodial account (UGMA/UTMA) to save for a child, but the child named on the account would gain control once he or she reaches a specified age. These accounts have pluses and minuses:
  • Loss of control. The custodian controls the account until the child reaches a specified age, typically 18 or 21 (rules vary by state). Once the account beneficiary reaches that age, he or she can use the money for anything. This might be a concern for people who fear that the beneficiary might spend the money unwisely or on noneducational items. On the flip side, giving the child control could prevent the parents from intervening in the account.
  • Modest tax benefits. The interest, dividends, and capital gains each year from the UTMA are reported under the child’s Social Security number. If the child is a minor (or full-time student under age 24), the first $1,050 earned in 2015 is tax exempt. The next $1,050 is taxed at the child’s tax rate, typically lower than the parents’. Any yearly earnings above $2,100 are taxed at the parents’ rate. However, all withdrawals face taxes on capital gains.
  • More flexible investment options. While the loss of control might be a disadvantage to many parents, the greater range of investment options in a custodial account versus a 529 plan could be attractive to a knowledgeable, self-directed investor.
  • Less student aid. Because custodial accounts—UGMA/UTMAs—are counted as a student’s asset, they are generally factored into the EFC at 20%, which is much higher than the 0%–5.6% factored in for parental assets. See the EFC calculator.

  Coverdell ESAs offer tax-free savings but are limited.

  Coverdell ESAs offer a tax-deferred and potentially tax-free savings option if used for college expenses or other education expenses from kindergarten through 12th grade. Withdrawals are tax free if used for qualified expenses for taxpayers who don't claim an American Opportunity credit or Lifetime Learning credit for the same expenses in the same year. Coverdell ESA benefits and disadvantages include:
  • More investment options. Coverdell ESAs have a greater range of investment options than 529 plans, and could be attractive to a knowledgeable, self-directed investor.
  • Lower contribution limit and possible confusion. Coverdell ESAs have a low annual contribution limit of $2,000. This is the total amount that all individuals can contribute to one account—or to multiple Coverdell accounts for the same beneficiary—in any year. Unless all family members know what others are contributing and how many accounts have been opened, it could be easy to make an excess contribution. In that case, the holder of the account would owe a penalty.
  • Income eligibility factor. The ability to contribute to a Coverdell ESA is phased out for single tax filers with modified adjusted gross income (MAGI) between $95,000 and $110,000 and for joint filers with MAGI of $190,000 to $220,000.
  • Loss of control for grandparents. Most ESAs require the child's parent or guardian to be responsible for the account. In losing control of the account, a grandparent would no longer have the option of transferring the money to a different beneficiary, or of withdrawing the money if needed for other purposes. That said, there is no law that prevents a grandparent from opening a Coverdell account—if he or she can be certain that no one else plans to open one or if the amount the grandparent is contributing would not interfere with the parent's contribution.

  Important considerations on 529 plans

  In many situations, a 529 account may prove to be an attractive education funding vehicle. However, there are some considerations that grandparents should take into account. For example, if financial aid is a concern, it would make sense to discuss options with the parents in order to come up with an appropriate plan. For example, it may help if the parents pitch in for the first few years of college and the grandparents help for the last year, after the final financial aid decisions are made.
  One strategy is to wait until late in the student's junior year before withdrawing from a grandparent’s 529 college savings plan account. That way it wouldn't affect eligibility for aid even in the senior year. Alternatively, the grandparent could simply choose to not open a 529 account but instead give to the parents’ existing account if retaining control isn't important. Some grandparents just want to make a simple gift and have no ongoing involvement.
  A major drawback to ownership of a 529 plan account for grandparents who aren’t that well off is the possible loss of Medicaid assistance. The 529 plan account balance may have to be spent on your care before Medicaid payments could begin. For more information, please check with your state Medicaid office.
  Also, when it comes to estate taxes, one catch is that if you were to take advantage of the annual gift-tax exclusion and front-load five years’ worth of gifts to your grandchild, and you died during that five-year period, the contributions for any remaining years would be brought back into your estate.
  "The 529 plans are particularly attractive as a savings option for younger children because of the front-loading option and the long-term market growth potential," says Ajay Sarkaria, a senior wealth planning specialist at Fidelity Investments. "They also offer you some flexibility if you own the account. In an emergency, you could withdraw the money, but you’d pay a penalty and taxes on the earnings." No other vehicle offers this combination of estate reduction while retaining access to the account.

  Open a 529 plan in an UTMA.

  Another approach for grandparents combines features of both custodial accounts and 529 college savings plans: opening a 529 college savings plan within an UTMA. By placing a 529 plan within a custodial account for which the grandparent is custodian, the grandparent can retain control until the student becomes of age (generally 18 to 21, but varies by state). After that, the student would have control, but must use the money for college expenses or pay a penalty.
  "This would allow you to receive tax-deferred growth and spend the money tax free on college expenses, plus it would ensure that the student receives the money no matter what," Bernhardt says. That would protect against the risk that a parent might withdraw money from a child’s 529 plan and spend it on something else. Consider a scenario where the grandparent contributed generously to a 529 plan account owned by a parent, who then withdrew the money for his or her personal needs, willingly paying a 10% penalty plus taxes on any earnings. In brief, it comes down to trust, and one's desire for flexibility and control.
  Family members can benefit greatly from working together. "Consider the student’s financial aid picture," Bernhardt says. "It’s good to have an open dialogue and coordinate closely with the child and the parent."

  Pay for college directly.

  An estate-planning advantage of paying directly is that the direct payment is not considered a gift to your grandchild, which means that you can also make an annual exclusion gift to the same grandchild. However, this approach could sharply limit financial aid eligibility, because direct payment of tuition by a grandparent could reduce subsequent financial aid dollar for dollar.4 Also, while paying tuition directly will not be considered a taxable gift, you would still not have the years of tax-advantaged savings that you would have with a 529 plan or a Coverdell ESA.
  Under certain conditions, a Roth IRA might be an attractive and flexible account type for accumulating education funding assets. You should speak with your accountant or your financial adviser for guidance on your particular situation.

  It's never too late.

  "It's never too late for grandparents to help with their grandchildren's college expenses," Sarkaria says. "While 529 plans might be ideal for younger grandchildren, you always have the option to pay directly for college tuition expenses once they are in college."
  Whatever you do, begin by understanding all your options, and think them through carefully.

Get More Yield On Your Cash

CDs and short-duration bonds may offer higher yields but more risk than savings accounts.

• FIDELITY VIEWPOINTS

As of mid-January, standard rates on savings accounts at the nation’s largest banks were around 0.01% to 0.03%.1 That’s not nothing, but it sure is close.

The bad news for savers is that there isn’t a lot of yield to be found, at least not from investments that are safe enough to be considered as a home for your cash. But even if you can’t earn a lot on your cash, that doesn’t mean you can’t do significantly better.

“There are a range of income options that can offer a meaningful increase in income; you could potentially increase the yield on your savings by a significant amount,” says Richard Carter. “The key is to understand what you need the money for, and then find an option that makes sense for your situation.”

First consider your goals

Before you look for higher-yielding options, take a second to reconsider the role of your cash in your financial plan. 

There was a lot of noise in the investment markets around rising rates last year, but for investors with a lot of cash, the story was pretty much the same: paltry yields on bank accounts and money market funds. With interest rates so low, you may have wondered whether you should just stuff your cash under a mattress.

But while finding yield in the short-term market has been challenging, it isn't impossible. You may be able to boost the income your cash allocation produces—but the downside is that you have to take on greater risk.

To determine whether it makes sense to accept greater risk in exchange for greater yield potential, consider the purpose for your cash investments. In some cases, you may require absolute stability, but in others you may be willing to accept some possibility of declines in exchange for higher interest payments. The decision comes down to your needs: the role this allocation plays in your overall portfolio, and what you hope to get out of it given your needs and time horizon.

Low yields explained

In December 2008, the Federal Reserve cut the target federal funds rate—a key benchmark for short-term interest rates—to a record-low range from 0.00% to 0.25%. The Fed’s goal was to help pull the U.S. economy out of a deep recession and financial crisis.

The low federal funds rate has acted as an anchor on yields offered by short-term instruments such as Treasury bills, deposit and savings accounts, money market funds, and other short-term bond funds. The average taxable money market fund paid a seven-day yield of just 0.02% as of June 23, 2015, according to money fund tracker iMoneyNet, while yields on Treasury bills with maturities of three months or shorter hovered below 0.05%, and have even dipped into negative territory, at times, during the past five years, when nervous investors flocked to the highest-quality securities. 

Digging into risk

Some shorter-term investment options offer significantly more yield than money funds and T-bills, but generally have either lower credit ratings or longer maturities than the securities that make up traditional short-term holdings. Those characteristics make the securities more vulnerable to declines, so you may need to be able to stomach minor downturns in your principal value, depending on the use you have in mind for your money. In general, most investors manage the risk level of their portfolios by making decisions about the equity allocation or fixed income allocation. But to a lesser extent, you can make these same choices within the short-term portion of your portfolio.

Bear in mind the following risks when determining whether to pursue higher yield with a portion of your cash allocation.

Credit risk

Corporate bonds pay significantly more yield than Treasuries, to compensate for the greater risk that the issuer will default. The greater the expected risk, the larger the yield premium a corporate bond or bill offers compared with a Treasury with a comparable term.

More credit risk may mean more yield		Yield
Higher credit quality	Government-backed 3-month Treasury bills	0.02%
Lower credit quality	Investment-grade 3-month corporate paper (financial)	0.85%
Data as of 6/17/15. Source: Fidelity.com Whether it makes sense to reach for yield by extending further down to weaker credit ratings—and how far it makes sense to reach—depends largely on how you intend to use your investments. If you need the money for everyday expenses, you probably can’t abide any fluctuation in the value of your principal, so you may want to consider a money market fund, one of the lowest-risk investment options.1 On the other hand, you may be able to tolerate the occasional blip in your account balance—for example, when investing the cash allocation of a long-term portfolio or a portion of your emergency fund. In that case, you may want to hold a portion of your cash in higher-yielding securities. If you do want to invest in lower-rated securities, it is important to remember that lower credit ratings usually indicate a weaker balance sheet and a higher risk of bankruptcy for bondholders. So it is important to perform research on the underlying company and the specific features of an individual bond—or you could invest in a bond fund to tap into professional research and management capabilities. Interest rate risk A steep yield curve View Larger Image Source: Fidelity.com as of 6/18/15. Compares U.S. Treasury bonds and A-rated corporate bonds. Find current data and other credit qualities here. Another way to secure higher yields is to hold securities with longer terms. In general, when two bonds with comparable credit ratings have different maturity dates, the one with the longer term will typically pay more yield, and be more sensitive to interest rate changes. Investors chart the different yields offered by bonds with various maturities on a graph called the yield curve. The graph recently looked like the chart to the right. Fixed income investors refer to the difference between the yield of longer- and shorter-maturity bonds as the steepness of the yield curve. When the yield curve is steep, it means that you can earn more income by investing in longer-maturity bonds. The same principle holds true for different maturities on the shorter end of the curve: Typically, a longer-maturity bond will offer more yield than a shorter-maturity bond, even if you are comparing one- and three-month bonds or one- and three-year bonds. The trouble is that longer-term bonds carry greater interest rate risk: If the general level of interest rates rises, bond prices will usually fall—and they’ll fall further for longer-term bonds than for shorter-term bonds. Short-term yield curve View Larger Image Source: Fidelity.com as of 6/18/15. A bond’s sensitivity to interest rate changes is expressed by its duration (technically, the weighted average time until the bond’s future payments). As a rule of thumb, an investment-grade security with duration of 1.9 could be expected to lose approximately 1.9% each time interest rates rise by 1%. Likewise, it could gain 1.9% when interest rates drop by 1%. Considering that interest rates are hovering at or near their historic lows, they have much more room to go up than down, causing many investors to worry about potential interest rate risk. Some investors are limiting their holdings to very short-term securities to limit the damage from any interest rate hikes. But these investors are earning little to no yield on such securities—and while the Fed has announced that it is considering raising rates in 2015 or 2016, not one knows exactly when, or by how much, rates could rise. Again, consider your need for cash. If you are looking for the least risk, keep your money in a money market, savings, or checking account. If you do use one of these accounts, look for higher introductory interest rates that may be available, and watch out for ATM surcharges, minimum balance fees, and other charges. If you can handle a decline in your principal, you may want to hold a portion of your allocation in longer-term securities. According to Kim Miller, manager of Fidelity® Conservative Income Bond Fund (FCONX), "An investor in a money market fund is probably earning between 0.01% and 0.10% right now. The yield curve changes daily, of course, but an investor willing to take on a little more price risk and principal volatility—less than a typical short- to intermediate-term bond fund might offer—could pick up between 0.20% and 0.30% in yield for some of their short-term assets by moving out the curve marginally, to a duration of three to six months." In that case, you might consider shifting part of your short-term allocation to an ultra-short- or short-term bond fund. Or, if you prefer to invest through individual issues, you may want to build a ladder of bonds or CDs with sequential maturity dates—for example, holding equal amounts in securities with 6-, 12-, 24-, and 36-month maturities. If you do prefer to invest in individual securities, keep in mind that transaction costs will reduce yields, and you may need significant assets to buy enough bonds to build a diversified ladder.  Short-term yields and short-term ladder average yields Term (months) 6 12 24 36 Ladder** U.S. Treasuries  0.12% 0.65% 0.82% 1.18% 0.69% Agency bonds* 0.36% 0.78% 1.13% 1.44% 0.93% New issue CDs 0.50% 0.65% 1.15% 1.60% 0.98% Corporate bonds (A rated)*  0.80% 1.29% 1.78% 2.21% 1.52% Source: Fidelity.com as of 6/17/2015. Yields do not reflect transaction costs. *Does not includes Fidelity's $1 per bond secondary trade concession. **Ladder assumes purchasing an equal amount of 6-, 12-, 24-, and 36-month maturities.  Find up to date yield data Research the fixed income and bond markets on Fidelity.com "Despite low levels of absolute yields, the yield curve—which shows the difference between long- and short-term interest rates—is still moderately steep," says Richard Carter, Fidelity vice president of fixed income products and services. "This means the difference between a six-month Treasury bill  and a two-year Treasury note is significant. If you are comfortable with the staging of your maturities, have enough cash on hand to meet your needs, and invest in high quality credits, you can allow the investments to mature at par (the face value of a bond), and not concern yourself with day-to-day price and valuation changes." Making your choice When deciding how to invest your cash, make liquidity—how quickly you need access to the money—a central consideration. In general, the more comfortable you are with risk and the less liquidity you need, the more yield you can afford to pursue. Consider the following hypothetical examples: The goal: Everyday expenses The goal: Emergency fund Daily liquidity need: High Tolerance for losses: Low Vehicles to consider: Money markets, checking and savings accounts Daily liquidity need: High for a portion of the fund, lower for the rest Tolerance for losses: Low Vehicles to consider: A mix of highly liquid accounts, such as money market funds, and less-liquid options, such as CDs or conservative bond funds The goal: Near-term savings target The goal: Low-volatility, "short-term" allocation in long-term portfolio Daily liquidity need: Low Tolerance for losses: Low Vehicles to consider: Treasury bonds and FDIC-insured CDs with maturities corresponding to the date you need your money Daily liquidity need: Low Tolerance for losses: Moderate Vehicles to consider: A range of bonds, bond maturities (ladder), and/or bond funds representing various credit qualities and short durations The bottom line Even in low-rate environments, there are ways to increase the returns on short-term investments. But as the cliche says in investing, there is no free lunch. More yield generally requires assuming more risk. The key: make sure your choices match up with your goals and your personal tolerance for risk.

BEFORE BUYING A HOUSE ... How Much House Can You Afford?

Before you buy, four factors to help you see how much house you can comfortably afford.

• FIDELITY VIEWPOINTS
• So you’ve decided to buy a home. Congratulations! But before you embark on the sometimes exciting, sometimes nerve-racking process of looking for a house, it’s important to take a step back and evaluate how much you can comfortably afford.
  “The two big mistakes that many first-time homebuyers often make are buying too much and buying too early,” says Adheesh Sharma, a director in Fidelity’s Strategic Advisers, Inc.
  Taking the time to calculate how the cost of homeownership fits into your budget can help you avoid these pitfalls. Here are four factors to keep in mind as you consider what homeownership costs you’re willing and able to assume. Also, use our simple calculator: How much house can I afford.

  1.	Save for a significant down payment.

  
  
  In most cases, you’ll need to contribute a down payment of 20% of a home’s value in order to secure a mortgage. There are other options for buyers who haven’t saved enough, but these options are more expensive.
  For example, if your down payment is less than 20% of the home’s value, you may end up paying a higher mortgage rate and be required to get private mortgage insurance (PMI). PMI generally costs from 0.5% to 1% of the total loan per year until your loan balance drops to 80% of what the home’s value was at the time of closing. The purchase price often serves as the appraised value, but you could have the house reappraised later and potentially eliminate PMI if you think that you may have achieved less than 80% of your home’s value. Appraisals, however, cost money too.
  To hold costs down, keep saving until you can afford at least a standard 20% down payment. Use our calculator below to get a sense of how much you might afford to spend on a house, given your current income and savings.

  2.	Make sure your finances and credit are prepared.

  
  
  Many people start the home-buying process by submitting their financial information to a mortgage lender. The lender will evaluate factors including your savings, income, and credit score to preapprove you for a loan of a certain amount. So, make sure your credit score is as high as possible—that can help you get a better mortgage rate.
  Also, beware of taking on too much debt. “Just because a bank tells you that you can borrow $300,000 doesn’t mean that you should,” cautions Sharma.
  When lenders determine how much of a loan to offer you, they look at your debt-to-income ratio—that is, your monthly debt obligations divided by your monthly income. Generally, lenders like to keep that ratio between 36% and 42%. If you have no preexisting debt, a lender might approve a loan that amounts to 42% of your income.
  But a large mortgage also means sizable monthly payments—which might make it hard to meet your other financial priorities. A good rule of thumb is to hold your housing costs to about 30% of your monthly income. The U.S. Department of Housing and Urban Development considers families who pay more to be “cost burdened”; such families may have difficulty covering other important expenses.

  3.	Make sure the mortgage fits your financial situation.

  
  
  Before you sign any loan paperwork, make sure you’re educated about the different kinds of loan options that are available to you, and which ones may make sense for your situation. Often, there are so many options involved that it’s like comparing apples to oranges. Different options will have different effects on your budget. Some will cost less in the short term and more over time, and some vice versa.
  For instance, there are alternative loan programs, such as interest-only loans, which allow you to pay just the interest on the loan without paying down any principal. Or there are 80-10-10 loans, also known as piggyback loans, which essentially offer borrowers two loans bundled together to cover 90% of the home’s cost (while you contribute 10% as a down payment). These loans allow you to contribute a lower down payment and avoid PMI—but they’ll cost you more in the long run, because you’ll have a higher interest rate and a bigger monthly payment.
  “Some people explore all sorts of options to afford a down payment, from 80-10-10 loans to taking loans from their families, to taking loans from their 401(k) plans,” says Sharma. “But all those options put a lot of pressure on your budget. Even though they might seem like a good deal at the time, they can end up being very stressful for many people.”

  4.	Think beyond the mortgage.

  
  
  Many homebuyers focus on the down payment and monthly mortgage costs when considering how much home they can afford, but being a homeowner entails other costs as well. At the time of purchase, you’ll be responsible for closing costs, which may amount to several thousand dollars. Also, take into account the costs of home insurance, property taxes, and any home ownership association fees or condo fees.
  And then there are the costs of maintaining and improving your home. “New homeowners are often surprised by the unexpected costs that come up in the first few months,” says Sharma. “You want to make sure you have some savings set aside to take care of those expenses.”
  Finally, don’t forget about your other priorities, such as saving for retirement and, if you have kids, their college education. If buying a house would put such a crunch on your budget that it would put these goals in jeopardy, you might consider continuing to rent for a while.
  Once you’ve reviewed your savings, considered your budget, and factored in your other priorities, you’ll have a much better sense of how much house you can comfortably afford. That way you can feel confident about taking this significant step.